Opinion: The elephant has to watch its steps
The lessons from the IMF’s annual assessments over the years are that optimism needs to be taken with a pinch of salt while risks must be heeded
Earlier this month, the International Monetary Fund (IMF) released its annual assessment of the Indian economy as per Article IV of the Articles of Agreement with member countries. Along with that report, it released the companion volume, “Selected Issues”, that delves deeper into, well, selected issues. The government was pleased with the report. The “elephant” metaphor has been unleashed again. It is not just lumbering but may even be picking up pace. The economy, in real terms, is projected to grow at 7.3% in the current financial year ending March 2019, and, in the next financial year, it will grow at 7.5%. So far, so good. The interesting stuff is always in the details.
In 2007, when optimism about the Indian economy was rife—the elephant had actually morphed into a cheetah, according to some—India’s potential growth was estimated at 8%. Take a look at the Article IV assessments for the years 2007 (February 2008) and 2008 (June 2009) to notice the drastic change in tone. From one of backslapping all around in 2007, it had turned into virtual panic in 2008. In 2007, the IMF had attributed the dream run of strong growth and macroeconomic stability to sound policies and past structural reforms. Some of us had warned that India’s high growth was neither sound nor structural. That the tributes were ill-founded was exposed by the fact that by 2012, the IMF had reduced its estimate of India’s potential growth to 6.5%. Now, in the report for 2018, the IMF upgraded its estimate of India’s potential growth to 7.3%, with the possibility that it can rise to 7.75%. For all the missed opportunities, this government has improved India’s economic growth potential. That must count as an important achievement.
But that is not a given because, even after the crisis of 2008 ended and India’s growth rate rebounded, as late as 2012, the IMF had maintained that India’s potential growth estimate was 8-9%. Notwithstanding fancy econometrics, such estimation methods are backward looking and probably attach a higher weight to recent growth performance. In this context, it is worth noting that the risks to the economic growth forecasts for 2018-19 and 2019-20 are entirely on the downside, and that is fair. The monsoon may have recovered but global asset market and economic growth risks are rising by the day, not to mention the risks of geopolitical conflicts. For a permanent and sustained improvement in potential growth, India’s savings rate has to increase and the IMF’s projections for India’s savings rates in the years to come do not bode well. Improving the savings rate is an endogenous problem and the chain of answers to the problem of low savings is long and extends well beyond economics.
On other fronts, the good news is that of the estimated recapitalization needs of the banking sector at 1.3% of gross domestic product (GDP), only 0.6% was raised in 2017-18. Completing the recapitalization plan in the current financial year based on performance and future growth prospect will further enhance credit growth prospects. The government has claimed that recovery rates from the steel sector will be higher than provisions and, hence, positive. But that does not take into consideration the possibility of fresh bad debts in other sectors. In this regard, the Fourteenth Finance Commission had called for an evolution of “criteria for the future fiscal support from budgetary resources for majority government-owned financial institutions and, in the process, go into the multiplicity of enterprises in each financial activity”. That does not sound like a headline-grabbing activity but given the stretched fiscal situation (India’s fiscal deficit and debt ratios are among the highest even in the developing world), it would be a big reform step.
On the multiplicity of institutions, it is interesting that the IMF calls for greater competition in the banking sector. That might well be a case of “frying pan to the fire”. Competition in the financial sector does not enhance financial system stability. It can actually undermine it. It sets off competition for asset growth and risk considerations fail to figure prominently in the hot pursuit of asset growth. Throw in executive compensation plans that are tied to short-term top- and bottom-line performance, and the recipe for future banking crises is ready. The current crisis is still festering and the public mood is receptive to a comprehensive relook at the banking sector. The government should seize the opportunity, formulate plans for restructuring the sector, put them up for discussion and be ready to implement them after the election in 2019. In the meantime, making banking supervision ownership-neutral should be possible through executive orders.
The IMF’s recommendation for more market discipline on state government finances, by removing the implicit federal guarantee, if necessary, evokes a smile. The disciplining power (or, more precisely, the lack of it) of financial markets on governments has been amply in evidence pre-and post-2008 crises. Even as debt and leverage ratios mount, the required rates of return have declined. So much for market discipline.
In sum, the lessons from the IMF’s annual assessments over the years are that optimism needs to be taken with a pinch of salt while risks must be heeded. That is asymmetry for you. Second, policy recommendations that appear to stem from ideological considerations must be regarded sceptically.
V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk
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